The Bank of England has been left with a £48bn black hole at the heart of its
money printing programme following the Treasury’s decision to seize the
surplus cash in the scheme.

Under quantitative easing (QE), the Bank has created £375bn of new money to buy government bonds – gilts – from pension funds, insurers and banks, with a nominal value of just £327bn. As a result, if the Bank holds the gilts until the date they mature, it will incur a £48bn loss on the principle value of those investments.

The figure has not been disclosed before but can be found buried in the Bank’s statistical releases. The first bond matures in March next year, when the Bank will crystallise a £500m capital loss on a £6.6bn investment.

The disclosure will pose fresh questions about last week’s decision by the Treasury to transfer from the Bank the £37bn of interest payments made on the gilts. The move will make the public finances look better when the Chancellor updates his forecasts at the Autumn Statement next month.

Andrew Lilico, an economist with Europe Economics, said that, by grabbing the surplus cash “the Treasury is essentially taking a £37bn dividend on a project that is £48bn in the red”.

Simon Ward, chief economist at Henderson Global Investors, said the scale of the nominal loss raised concerns about the cash transfer. “Arguably, the Treasury should only have transferred any surplus above the £48bn because then they could have said the extra might not have to be repaid in the future,” he said.

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George Osborne last week admitted that he may have to make payments to the Bank to cover future losses “as Bank Rate rises or capital losses crystallise”. But neither the Treasury nor the Bank disclosed the scale of nominal losses on the QE programme. To date, the Bank has only publicly disclosed the mark-to-market value of the assets.

The mark-to-market value has been flattered by the UK’s safe haven status and the QE programme, which between them have pushed up demand for gilts and consequently raised prices. The latest accounts for the Bank subsidiary that manages QE show that the £287bn of assets purchased by February this year were £20bn in profit on a mark-to-market basis.

However, economists said the figure dramatically overstated the financial health of the scheme. “On a mark-to-market basis there will almost certainly be huge losses for the Treasury as QE bonds crash in price when interest rates rise. The hold-to-maturity value is the highest plausibly realised value for these bonds from here, and shows a £48bn loss,” Mr Lilico said.

The figures are likely to reinforce concerns that the Bank has compromised its independence by allowing the Treasury to take back the cash surplus. It is now dependent on an agreement with the Treasury for interest payments to be transferred back as bonds mature or are sold, and an indemnity to cover any future losses.

Treasury and Bank sources believe the scheme will show an overall profit once it has been wound down, as savings on interest payments outweigh capital loss.

Currently, the average yield on the portfolio is about 4pc – which the Treasury would be having to pay in full if the gilts were owned by the private sector. Instead, the Bank is paying just 0.5pc on the money created to buy the gilts and is handing the excess back to the Treasury. The excess is the cash surplus.

However, if interest rates rise above 3pc, the cash position will reverse and the QE portfolio will start making a loss. The Bank has said it will raise rates before it starts selling gilts. On past trends, the cash surplus will not cover the £48bn nominal loss until April 2014. The Treasury has insisted that the move was merely a “cash management operation” and brings the UK into line with Japan and the US.

Sir Mervyn King, the Bank’s Governor, has described the furore as “a lot of fuss about nothing”.

The Telegraph Investor

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